If you are a US citizen or resident alien earning income abroad, you might face taxation both in the foreign country and the United States. To mitigate the risk of double taxation, the US offers the Foreign Tax Credit (FTC). This credit allows you to reduce your US tax liability by the amount of foreign taxes you’ve paid. Let’s break down how it works and how you can claim it.
What Is the Foreign Tax Credit?
The FTC is a dollar-for-dollar credit against US taxes owed, based on the amount of income tax paid to a foreign government. Instead of excluding foreign-earned income (as with the Foreign Earned Income Exclusion (FEIE)), the FTC allows you to claim a credit for foreign taxes directly against your US tax liability.
Who Is Eligible for the FTC?
To qualify for the FTC, you must:
- Be a US taxpayer (citizen or resident alien).
- Have foreign source income that is taxed by a foreign government.
- Have actually paid or accrued the foreign taxes.
- Not have claimed a credit for taxes excluded through the FEIE.
How to Calculate the FTC
The amount of credit you can claim is the lesser of:
- Foreign taxes paid or accrued, or
- The US tax liability on the foreign-sourced income.
To calculate the credit, use Form 1116 (Foreign Tax Credit). The form guides you through:
- Identifying eligible income
- Converting foreign currency amounts to USD
- Calculating the credit based on income type (such as passive or general income)
Common Scenarios Where FTC Is Beneficial
- Working Abroad: If you are employed overseas and your income is taxed both locally and by the US.
- Investments in Foreign Stocks: If your dividend income from foreign companies is subject to withholding tax.
- Owning Property Abroad: Rental income from a foreign property that is taxed locally.
Limitations and Considerations
- No Double Benefit: You cannot claim the FTC on income that you have already excluded under the FEIE.
- Carryback and Carryforward: If your credit exceeds the US tax owed, you can carry it back one year or forward up to ten years.
- Tax Treaties: Some countries have treaties with the US that can affect your ability to claim the credit.
Final Thoughts
The Foreign Tax Credit is a valuable tool to reduce double taxation on your foreign income. Understanding how to calculate and claim it correctly can save you money and simplify your tax filing. If your situation is complex, it’s wise to consult a tax professional experienced in international taxation to maximise your benefits.
The information in this blog post is for general informational purposes only and does not constitute professional tax advice. We strongly recommend consulting a qualified tax professional before making any decisions. US Expat Tax Advisor is not liable for any actions taken based on this content.
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